A debt-trap spanning 75 years: Pakistan’s journey towards a sovereign default

Today, the cost of interest payments on debt is Rs4.8 trillion, 50% of our federal budget

ISLAMABAD:

Pakistan – for the first time in its peacetime history – is on the verge of a sovereign default. While this is due to a host of factors, the root of the problem lies in imprudent economic and debt policies – in only 22 years, the nation’s gross public debt has increased over 1500%.

Since the year 2000, every successive government – irrespective of being a military dictatorship, civilian or hybrid regime – has almost doubled the country’s public debt pile at the end of their political tenure. In 2000, Pakistan’s gross public debt was Rs3.1 trillion. Statistics from the Ministry of Finance show that by the time General retired Pervez Musharraf’s dictatorship ended in 2008, Pakistan’s gross public debt had jumped to Rs6.1 trillion – an increase of 100% in the span of eight years.

By June 2013, Pakistan’s public debt had mushroomed to Rs14.3 trillion – an increase of 130% in the five years of Pakistan People’s Party (PPP) being in power. By the time Pakistan Muslim League-Nawaz’s (PML-N) tenure ended, from 2013 to May 2018, public debt had jumped to Rs25 trillion – an increase of 76%.

Then came the government of former Prime Minister Imran Khan from the Pakistan Tehreek-i-Insaaf (PTI), who vowed to lessen the debt burden to Rs20 trillion. At the end of his 43-month rule, however, public debt stood at Rs44.3 trillion – recording an increase of Rs19.3 trillion or 77% in less than four years.

Today, Pakistan’s total debt and liabilities have sky-rocketed to over Rs60 trillion. The nation added Rs12 trillion, or one-fourth of its total debt incurred in the past 74 years, in the diamond jubilee year.

Public debt is a by-product of many things; expenditures that are higher than revenues, a foreign-savings financed economic growth model, the depreciation of the local currency against foreign currencies (mainly the greenback) among other factors.

The other deadly combination to exist in Pakistan is to have relatively well-off people and a poor government. The nation’s informal economy is generating huge amounts of wealth, particularly in the real-estate sector, creating demand for foreign goods that are being bought via increasingly pricey foreign loans – adding to the country’s foreign financing needs.

Over the years, Pakistan’s addiction to programme loans (read as non-project loans) also enabled it to run high budget deficits. Over time, however, this caused a shift in the debt structure and has now brought the country to the brink of a sovereign default – with multiple short-term foreign loans maturing one after another. These short-term loans are major contributors to the country’s external financing requirements increasing to unsustainable levels – now at around $32 to $34 billion every year for the next three years.

The State Bank of Pakistan (SBP)’s archives show that in the year 1971 – when the country was disintegrated into two – we took $564 million in foreign debt. All of which was taken under a long-term financing scheme which was used to create assets or make food purchases.

Dr Kaiser Bengali – a renowned economist – once wrote that if we look at the last two decades, we find that grant components have gradually been eliminated from international funding, be it from donor countries, consortium partners or international financial markets and banks, particularly the International Monetary Fund (IMF) and World Bank. The trend now is to give credit – not aid. Since developing countries have predominantly faced a balance of payment crisis over the last 20 years, they are being supported via loans given under certain specific programmes – such as the structural adjustment programmes of the IMF. These loans are generally granted for balance of payment support, debt servicing and other similar purposes.

According to Dr Bengali’s research paper, project aid has been reduced quite considerably and soft loans have been reduced or replaced entirely with commercial loans. Short-term, high-interest lending is brilliant but vicious cycle that is hugely exploited – not only do these loans widen the debt burden, they literally create a balance of payment crisis – for which countries like Pakistan keep acquiring more and more loans at high-interest rates to payback.

Dr Bengali has written extensively on this subject and has warned of its unavoidable debt trap many a times. And as predicted, today the country needs to repay a foreign debt worth $23 billion, with a majority of it being short-term foreign commercial loans and cash deposits from Saudi Arabia, China and the United Arab Emirates (UAE).

Since international aid and loans are being utilised in the budgetary framework of the economy, we have been noticing that the share of development expenditure, as of the percentage of GDP, has been reduced from an average of 8% to 3% over the last couple of decades, according to Dr Bengali’s research. This means that the aid given has not literally been used for the development sector, but has instead been unwisely used to support the balance of payments and debt serving of expensive loans, defence and public administration, and subsidies in public services.

Besides, expenses on public administration and defence were not decreased, despite the fact that successive governments could have moved to curtail them. If we look at public finance, hardly any money from the tax revenue has been spent on health, housing, education, transport or the development of agricultural and physical infrastructure.

The World Bank initiated lending to Pakistan with a loan for railways in 1952. The Asian Development Bank began providing lending in 1969, with a loan for the Industrial Development Bank.

Over a 54-year period, from 1960 to 2014, the World Bank provided 310 loans totalling $26.5 billion. Of these, 45% were project financing and 55% were programme loans, according to Debt Composition: Consequences for Economic Development by Dr Kaiser Bengali and Mehnaz Hafeez.

In terms of amount, 39% of the loans have been project loans and 61% have been programme loans, according to the authors.

This trend has further deteriorated in the past eight years. The Economic Affairs Ministry debt reports show that now Pakistan takes about 85% of its total foreign loans under “non-project” loans. Consequently, Pakistan will never be able to pay back these loans without taking new loans.

The year 1988 has been earmarked as one of structural reforms that led to many changes in Pakistan’s debt profile. Many non-project loans were sanctioned by the World Bank in the name of reforms that have also contributed to sinking the economy.

The 1990s onwards saw a major shift in the composition of lending, writes Dr Kaiser Bengali. Over the 24-year period, 1980-2014, the World Bank provided 163 loans totalling $20 billion. Of which, 22% were project loans and 78% were programme loans. In terms of amount, 29% were project loans and 71% were programme loans, he added.

Project and Programme loans have a significantly different impact on public finances and the development process. By and large, Project loans are utilised to create an economic asset which, in the due course of time, begins to provide a flow of additional income and can be used to repay the loan, according to the authors of the paper.

Programme loans, on the other hand, do not create any economic asset or additional flow of income. As such, it is repaid from the existing income – thus, forcing a reduction in public expenditure – or a new loan has to be contracted to repay the old one. Simply speaking, Programme loans add to the debt burden.

The Way Forward

The cross roads at which Pakistan stands today requires an unconventional approach. The Ministry of Finance needs to come out of its state of denial and needs to negotiate early public debt restructuring. The restructuring, however, should not only be limited to the external debt – domestic banks should also be ready for a haircut.

Today, the cost of interest payments on the debt stock is Rs4.8 trillion, which is equal to 50% of the federal budget and 64% of the Federal Board of Revenue (FBR)’s taxes. The government cannot avoid debt restructuring even if it gives up its entire budget. The inevitable will happen – we just don’t know when.

Today, the gross foreign exchange reserves stand at $6 billion – not enough to back even one month of imports if the central bank were to cater to all its pending import requests. Today, effectively, Pakistan is reverted to a licensing regime, but the form has changed to grant permission for imports.

There are different definitions of a sovereign default. From a legal perspective, a default event is a contractually specified breach of the debt contract—most notably, a failure to pay scheduled debt service beyond the grace period specified in the contract.

Technically, however, Pakistan has already defaulted as it is not able to pay back loans taken from China, Saudi Arabia or the UAE because they are rolled over every year. The government needs to end its habit of taking conditions-free foreign commercial loans and the conditional budget support loans to finance its lavish lifestyle. This practice, which started peaking from the year 2014, has to end now.

The practice of signing subsidy cheques in favourof industrialists, and even under the Benazir Income Support Programme (BISP), has to end now. And industrialists must be told to either compete with the world or wind up their businesses.

Similarly, the tax havens must end. Traders must be brought into the tax net and owning more than two plots of land (for more than five years) should be banned – to divert the nation’s resources towards productive sectors of the economy.

There should no more be tax amnesty schemes and the non-combative defence budget should be curtailed. All businesses, owned by the military or civilians, should be brought into the tax net.

Painful decisions have to be made, if Pakistan wants to be seen as a responsible nation in the global community. While the western powers have waited for years to see Pakistan reach its dead-end – regrettably though, we’re here because of our own faults.